Currencies crack as dollar dominates

THE question among many investors, and perhaps to a larger extent the general public, is whether we are in another currency crisis or simply a victim of the US dollar’s mighty strength.

After all, the ringgit has plunged to levels not seen since the Asian Financial Crisis (AFC) of 1997/98.

Going back almost a quarter century ago, it was the attack on the Thai baht that triggered the massive speculative attack, not only on other regional currencies but also on other Asian currencies. The Thai government then was cornered to support the baht as the currency peg was unsustainable due to the growing current account deficit.

Last week, the Bank of Japan (BOJ) intervened in the currency market for the first time since 1998 as the yen fell to a fresh 24-year low following Boj’s decision to stand pat on its ultra-low interest rates policy. The increasing divergence of monetary policy adopted by the BOJ and the US Federal Reserve (Fed) saw the dollar/yen exchange rate surging past the 145 mark, a move that saw other currencies too taking a beating, including the British pound, the euro, and of course the ringgit. The pound fell to an all-time low, while the euro hit a fresh 20-year low.

Terminal FFR at 4.50%-4.75%?

The recent move by the Fed to raise the benchmark Fed Fund Rate (FFR) by 75 basis points (bps) to 3.00%-3.25% not only saw the Dollar Index surging to fresh 20-year highs but market’s expectations of higher rates going forward allowed more crowded trades to take a long position on the dollar. Based on the Fed fund futures, the market is now looking at another 75 bps hike in November, followed by a 50 bps hike in December.

That is not the terminal rate just yet as the market expects the Fed to continue to raise rates by another 25 bps each in February 2023.

This suggests that the FFR is expected to see a peak rate of 4.50% to 4.75% by the first quarter of next year before the Fed begins to scale back with a mild 25 bps cut in July 2023. Hence, having raised the benchmark FFR by 300 bps since the start of the year, the Fed is expected to increase the FFR by another 150 bps before pausing. No wonder the market is extremely bullish on the Dollar.

At what price?

As it is, the global markets have seen values of capital markets plummet by as much as US$30 trillion (RM139 trillion) from the peak as the hike in interest rates, higher inflation prints, and slowing economic growth saw markets reeling.

The US yield curve is now fully inverted with the 10-year and twoyear spread at minus 42 bps – the lowest level in more than four decades.

This has also caused a serious exodus from the fixed income markets repriced expectations of growth and rate hikes.

However, this time around, the outflows from the fixed income market did not shift to the battered equity markets but more towards cash deposit funds as investors foresee further losses in stocks.

After all, with the market anticipating further spikes in rates, surely investment in fixed income securities will lead to further capital loss while equity markets remain vulnerable to volatility as well as the risk of earnings recession in the coming quarters.

Hence, the cash funds or cash deposits are seen as a natural choice for now as investors see

cash as king.

Ringgit – A victim of global market shifts

As highlighted a couple of weeks ago in this column, the ringgit has weakened to levels last seen during the AFC not due to weak domestic fundamentals but more due to the dollar’s strength, which by now is well documented.

At the same time, Malaysia, along with other Asian or regional central banks, is also seeing depleting international reserves. Based on Bank Negara’s latest indicator, Malaysian reserves have fallen to Us$106.3bil (Rm467.8bil) as at Sept 15, 2022, from the recent peak of Us$116.9bil (Rm486.8bil) at end of last year.

The drop of more than Us$10.6bil (Rm49.2bil) in the international reserves this year and up to Sept 15, 2022, is contributed by a few factors and not necessarily intervention in the currency market.

Firstly, as with any central bank, not all of Bank Negara’s reserves are in US dollars and it is likely a basket comprising major currencies and Malaysia’s key trading partners.

Hence, it is widely believed that while the US dollars may be a dominant currency in Bank Negara’s reserves, the central bank may also have a significant holding of other currencies, including the Singapore dollar, the Chinese yuan, yen, euro, and pound.

The weakness of these currencies too would have contributed to the weaker international reserves held by the central bank in US dollar terms.

However, there is no doubt that there is some form of correlation between the weakness of our reserves and the level of the ringgit (see chart).

Re-basing the local currency and international reserves position to a base value of 100.00 as at end of 2020, the ringgit as at Aug 30, 2022, has dropped by 11.5%.

While gross international reserves as at end of August were firmer at Us$109.2bil (or Rm476.5bil) against Us$107.6bil (Rm432.2bil as at end of 2020), the net international reserves held by Bank Negara fell by a steep 11.9% to Us$83.76bil (Rm367.9bil) from Us$95.07bil (Rm381.8bil) as at end of 2020.

The steep decline is attributable to two factors. First, it is the central bank’s net aggregate short position in the forward and futures in foreign currencies, which increased to Us$15.1bil (Rm66.4bil) as at end of August-2022, from Us$5.3bil (Rm21.1bil) at end of 2020.

The Us$9.8bil (Rm45bil) increase represents some 186.7% increase over the space of 20 months. Second, it is the central bank’s loans in foreign currency loans, securities, and deposits that Bank Negara has taken which stood at Us$9.4bil (Rm41.4bil) in principal and interest as at the end of August 2022.

Compared with the central bank’s net liability position of Us$7.3bil (Rm29.3bil) at end of 2020, Bank Negara’s foreign currency loans, securities, and deposits increased by 28.7%, or Us$2.1bil.

Hence, while the central bank may have not actively intervened in the currency market and has sufficient gross international reserves, the net international reserve position, which stood at Us$83.76bil (Rm368.87bil) at end of August 2022 may be a cause of concern as on an adjusted basis, it represents 4.2 months of imports of goods and services and 0.85 times total short-term external debt.

A regional impact

Since the end of last year and drawing the same analysis for Singapore, Thailand, Indonesia, and the Philippines, one would note that a similar trend is observed as well as international reserves of these countries are down by between 8.8% for Indonesia to as much as 30.7% for Singapore.

Two central banks – the Bank of Thailand and the Monetary Authority of Singapore (MAS) may have intervened in the market to support their respective local currencies.

Singapore’s international reserves position, which stood at about Us$417.9bil (RM1.74 trillion) at the end of last year, plunged to just Us$289.4bil (RM1.3 trillion) in eight months! Out of the Us$128.5bil (Rm575.6bil) fall in the short space of time, some S$75bil or Us$55.1bil (Rm246.8bil), representing 42.9% of the total drop in reserves, was transferred to the government, while the balance of Us$73.4bil (Rm328.8bil) was an actual decline in the country’s reserves.

In Singapore’s case, it is widely believed that while MAS had taken steps to sustain the Singapore dollar nominal effective exchange rate by increasing slightly the slope of the band and re-centre upwards, it is widely believed that these measures have not been sufficient to strengthen the Singapore dollar against the US dollars.

Hence, a direct market intervention was necessary, as, without it, the Singapore dollar would have weakened even more.

Being a country that is very much import dependent, Singapore’s move to intervene in the foreign exchange market is to ensure it does not experience an ever higher inflation print, which is already at multi-year highs, hitting 7.5% year-on-year (y-o-y) in August 2022, while core inflation surged 5.1% y-o-y – both were highest since June and November 2008, respectively.

Thailand has seen its reserves drop by about Us$31bil (Rm129bil) since the end of 2021 to the current level of Us$215bil (Rm963bil), while Indonesia and the Philippines saw an 8.8% and 10.4% drop this year, representing a decline of Us$12.7bil (Rm56.9bil) and Us$11.4bil (Rm51.1bil) respectively.

During the same period, Malaysia’s gross reserves fell by Us$8.7bil (Rm39bil) or 7.4% to Us$108.2bil (Rm476.5bil) from Us$116.9bil (Rm486.8bil) at end of 2021, while net reserves declined by Us$20.9bil (Rm93.6bil) or down by almost 20% to Us$83.8bil (Rm368.9bil) from Us$104.6bil (Rm435.7bil).

Currency-wise, the Philippine peso is the worse performing South-east Asian currency, down by 14.8% so far this year, followed by the baht at 14.3%, ringgit at 11.2%, and the Singapore dollar and Indonesian rupiah are lower by 6.2% and 6.7% respectively at press time.

In conclusion, the dollar’s global dominant position is now strengthened by a confluence of factors and this includes not only the monetary policy divergence but also futile attempts by any central banks to support their local currencies as the tide is simply too strong.

Currencies will likely continue to be under pressure for some time until and unless we see the Fed taking a step backward and turning dovish.

A hawkish Fed is bad news for everyone for now, as it is a certain recipe for global imbalances, which would likely lead to just one outcome – financial turmoil, and hence an evitable global recession.